DarrenChervitz

NEW YORK (CBS.MW) -- Earnings shortfalls spell trouble for any company, but investors can be especially tough on those that are new to the market.

Just take a look at the stocks of recent IPOs telecommunications software developer Evolving Systems (EVOL)
EVOL, +0.00%
, employee recruiter Hall Kinion & Associates (HAKI)
haki
and restaurateur Friendly's Ice Cream (FRND)
frnd
, which all warned that second quarter earnings would fall short of analysts estimates. Since the warnings, shares have fallen by at least a quarter, leaving investors wondering if the crushed stocks are now bargains or dead money.

At least in the short-term, the hard-hit stocks are unlikely to find much relief. Investors and analysts typically remain reluctant to back a young company that has burned them until they have at least some proof that the problems were temporary.

Kiss of death

"People that bought in and lost money are going to try and get out as quick as they can and stay out," said Gerry Sparrow, director of research at St. Louis-based Sparrow Capital Management and a momentum-oriented investor who considers an earnings shortfall a kiss of death.

The damage is usually more severe and longer-lasting if a company disappoints in its first quarter as a public company, as was the case of Evolving Systems.

Not even a ratings upgrade by Evolving's lead underwriter, the well-respected Goldman Sachs, could keep its investors from heading for the exits. Evolving, which went public at 14 and rose as high as 20 5/8, was unchanged Monday at 9 7/8.

Generally, companies hoping to go public do their best to make their financial results look good in their IPO filing, so it's no surprise that many investors get skittish after an earnings shortfall. "Unseasoned stocks have no track record to fall back on, like General Motors (GM)
GM, +1.58%
," said John Fitzgibbon of the IPO Reporter.

Hybrid disaster

Hybrid Networks (HYBRE)
hybre
offers a clear demonstration of why such fear may be warranted. Many investors on the Internet investment bulletin boards were chatting up this company as a huge bargain earlier this year after the maker of Internet access equipment for the cable and wireless industry warned that it would post weaker-than-expected results for the fourth quarter of 1997.

"Unseasoned stocks have no track record to fall back on."

John Fitzgibbon IPO Reporter

Unfortunately, Hybrid has since dealt investors one disaster after another. The company had to warn investors of another wider-than-expected loss in the latest quarter, and then had to revise those results even lower. On Monday, the company said its review of earlier financial statements is continuing and that its accountant now says those documents can "no longer be relied upon."

Shares of the company, which recently had to add an E to its ticker due to the recent troubles, didn't open for trading Monday.

"That's the stuff class action suits are made of. Lawyers will go around screaming fraud ... and it will eventually be settled out-of-court," Fitzgibbon said.. "In the meantime, the stock's back is broken."

Indeed, Hybrid and the underwriters that handled the company's IPO, including lead manager NationsBanc Montgomery Securities, were named in a recent class action shareholder lawsuit.

Gradual recoveries

Of course, Hybrid's experience is somewhat unique. Many other newly public companies rebound from an early earnings shortfall quite nicely.

Recovery, however, tends to be slow and gradual, with investors stepping gingerly back in only if the company in question meets analysts' expectations in subsequent quarters. Take the case of The Children's Place Retail (PLCE)
PLCE, +0.55%
, which went public at 14. After rising as high as 16 1/8, the company's stock got rocked later that fall after the company failed to meet the consensus earnings estimate. Since the beginning of the year, however, the children's apparel retailer has slowly recovered much of the ground it lost, thanks in large part to a couple of stellar earnings reports and a hot market for retail stocks in general.

Other recent disappointers have also begun to recover from early problems. The stocks of both National Research (NCRI)
ncri
and Omega Research (OMGA)
omga
, two 1997 IPOs that fell short of expectations early on in their lives as a public company, have very slowly recovered from all-time lows.

Whether the recovery is long-lasting is another question. Friendly's Ice Cream, for instance, got hit hard when the company told investors a few weeks after going public last year that their interest costs were going to be larger than expected. Since that first warning, the stock had more than doubled, reaching all-time highs of more than 25 in early May.

But then Friendly announced the latest earnings warning. On Monday, shares closed at 15 7/8.

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